WILL GROWING NUMBER OF BAILOUTS MAKE ECONOMIC PROBLEMS WORSE?

September 11, 2008

Following the federal government's decision to nationalize mortgage giants Fannie Mae and Freddie Mac, the markets want clarity about what, exactly, Uncle Sam would do to protect another investment bank from the threat of bankruptcy. The markets want a more explicit guarantee that creditors won't suffer from their firms' folly, as such creditors would -- and should -- in a real free-market economy, says Investor's Business Daily (IBD).

The real nightmare would be if the government was to take on hundreds of billions of dollars of new risks on behalf of the taxpayers, as it has already begun to do with Fannie and Freddie, and find that there's not enough money in the U.S. Treasury to stem the decline in housing prices and thus end the banking crisis.

The open-ended risk here is already startling, says IBD. Consider:

If Fannie and Freddie experience losses in their mortgage portfolios of just 10 percent, taxpayers could pay $500 billion.

Losses of 20 percent could cost taxpayers more than $1 trillion.

The possibility of such losses is real, says IBD:

Between 2000 and 2006, home prices across 20 urban areas from Las Vegas to Cleveland more than doubled, on average.

They have fallen by less than 20 percent since then, but we have a long way to go.

However, 9.2 percent of mortgage borrowers are at least a month behind on their payments, the highest since a decade ago.

The government's shouldering of such losses through its Fannie and Freddie bailout and through future protection of other financial institutions could pose a danger to our fiscal health. A trillion-dollar loss at Fannie and Freddie would represent more than 10 percent of our national debt.

Such a hit, protracted over several years, could discourage foreign governments' banks and investment agencies from investing in our Treasury bonds, pushing up interest rates and mortgage rates, too, warns IBD.